Chile’s Peso Rout Distorting CPI Forwards to BBVA: Andes CreditSebastian Boyd
Traders in Chile’s forwards market are underestimating the outlook for inflation after the biggest plunge in the peso in two years, say Banco Bilbao Vizcaya Argentaria and Banco de Credito & Inversiones.
Forwards for unidades de fomento, the country’s inflation-linked accounting unit, are pricing in inflation this year of 2.12 percent, down from 2.16 percent the week earlier. BBVA and BCI predict the cost of living may rise 2.5 percent as the cheaper peso pushes up import costs. Consumer prices rose an annual 1 percent in April, the slowest pace in Latin America.
The peso has plunged 4.2 percent, the steepest decline of any currency in Latin America, since the central bank said on May 6 that the economy grew at the slowest pace in two years in March. The decline prompted traders to forecast the next move in interest rates will be a cut, just six weeks after they had predicted an increase. With tradable goods making up 58 percent of Chile’s consumer price basket and imports accounting for almost all the country’s energy needs, the weaker peso will lead to higher prices, said Jorge Selaive, the chief economist at BBVA.
“The market isn’t seeing the velocity in the recovery of inflation,” Selaive said by telephone from Santiago on May 24. “This depreciation will probably be transferred fairly rapidly into imported goods and retailers will be very tempted to pass on the depreciation of the peso to final prices.”
Costs are already rising. The state-owned refiner Empresa Nacional del Petroleo raised the price of wholesale gasoline in the Santiago region by 2.3 percent on May 23. The decline in the currency added seven pesos per liter to the price, the company said.
The peso weakened 0.2 percent to 491.1 per dollar as of 1:02 p.m. in Santiago today, heading for the weakest close since July 25 last year. The currency has fallen 3.7 percent in the past month, compared with 3.3 percent for the Colombian and Mexican pesos.
“More than May it should impact on June’s inflation because much of the depreciation has been in the last weeks of May,” Sebastian Senzacqua, an economist at Banco Bice in Santiago, said by phone from Santiago on May 23. “We expect the peso to end the year at 500 per dollar as the Fed cuts back its bond purchases and inflation to end the year at 2.5 percent.”
Federal Reserve Chairman Ben S. Bernanke told Congress on May 22 that the bank may slow the pace of bond purchases “in the next few meetings” if the Fed is confident gains in the economy can be sustained.
In the last four months of 2011, the peso plunged 12 percent because of concern that the slowing global economy would erode demand for copper, Chile’s largest export. Inflation beat analyst forecasts in the last quarter of that year by a cumulative 0.8 percentage point. The falling peso was partly to blame, the central bank said in its March 2012 monetary-policy report.
Traders are reluctant to bet on faster inflation again after overestimating price growth earlier in the year, Selaive said. Prices fell 0.5 percent in April after traders forecast a decline of 0.3 percent and economists predicted a 0.1 percent drop.
Sebastian Ide, the head of rates trading at Banco de Chile, said that while inflation will accelerate, falling commodity prices may soften the impact of the weaker peso.
“The bias in inflation has been upwards but people are still dubious about what the impact will effectively be,” Ide said by telephone from Santiago on May 24. “The exchange rate move has been somewhat offset by the decline in commodities.”
Foreign investors expect the peso to fall further, adding to pressure on inflation. They have added $9.2 billion of net bets against the currency in the forwards market in seven weeks and on May 24 had an $11.9 billion net short peso position, the highest since the central bank started publishing daily data in October 2008. Local investors, excluding banks and brokers, had a $15.7 billion long peso position on May 24, up $5.1 billion in seven weeks.
Foreign investors are pulling out of the currency as the lower rate expectations menace the carry trade, says Eugenio Cortes, the head of currency forwards at EuroAmerica Corredores de Bolsa SA in Santiago. In a carry trade, investors borrow in a currency with low interest rates to invest in another with higher rates. Investors who borrowed dollars to buy pesos returned 13.8 percent last year. They have lost 3.6 percent so far in May, according to data compiled by Bloomberg.
“The movement of rates in Chile is more likely to be down, not up, and that’s changed the scenario,” Cortes said on May 23. “Offshore investors closed their positions.”
Chile’s central bank has kept its benchmark rate at 5 percent for 16 consecutive months. The outlook for rates changed after the central bank reported economic growth of 3.1 percent in March, compared with the 4.7 percent forecast by analysts.
Copper prices have fallen 10.1 percent this year on the Comex exchange in New York, damping the outlook for the world’s largest producer of the metal.
“Copper affects growth expectations, which affects rates,” said Felipe Alarcon, an economist at Banco de Credito & Inversiones in Santiago. “At the same time, the dollar is strengthening globally so there are better returns elsewhere. It all indicates weaker emerging-market currencies.”
The yield on Chilean 10-year bonds rose two basis points, or 0.02 percentage point, to 5.21 percent today. The 10-year inflation-linked bond yield climbed two basis points to 2.4 percent.
The extra yield investors demand to buy Chile’s 10-year dollar bonds instead of U.S. Treasuries fell one basis point to 89 basis points, or 0.89 percentage point.
The cost of protecting Chilean bonds against default for five years using credit-default swaps fell one basis point to 74 basis points at 1:01 p.m. in Santiago. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if a borrower fails to adhere to its debt agreements.
A 10 percent depreciation in the peso in Chile would typically mean an 80 basis point increase in headline inflation after four quarters, Buscaglia said.
In this case the pass-through of the weaker peso to prices may be more notable after salaries rose 5.9 percent in the year through March, compared with inflation of 1.5 percent.
“Inflation expectations have to rise,” said Alarcon, an economist at Banco de Credito & Inversiones in Santiago. “We expect inflation to end the year at 2.5 or 2.6 percent versus what is being priced into the forwards.”